Looking at Deal Value Beyond the Headlines

May 24, 2017

The press release is the public’s first (and oftentimes only) view into the details of a transaction. However, while the press release is the victory lap of a transaction process, it rarely provides the full details of the transaction. Sure, it provides basic information on the economics and reason for a transaction, but several important details of value transfer are often omitted.

Companies often come to Locust Walk and say, “I want a deal like Company X got for Drug Y. Our drug is similar or better so our deal should be the same or better.”

It is always our goal at Locust Walk to deliver the highest value transactions for our clients and our track record of success shows that we are very good at doing so. But to truly deliver value, it is necessary to look beyond the headline and consider what the true sources of value are for a deal, most of which are never included or accurately presented in a press release.

The Biodollar Fallacy

If you’re reading this blog, chances are you know what a “biodollar” is. If not, an easy way to think of a biodollar is to assume that every contingent dollar in a transaction is guaranteed to be earned (i.e. all milestone conditions will be satisfied, regardless of how unattainable they may be). A transaction could therefore have a very high biodollar amount, but not be very valuable overall to the seller. It is important to look at the likelihood of achieving a milestone to determine whether there is any value in it. A press release will hardly ever mention what the timing, conditions, amount or likelihood is for any individual milestone in a deal, but these are critical to knowing what a seller is actually receiving.

Consider the following two structures for a Drug X with peak projected sales of $500M:

Deal 1: $25M upfront, $125M in total milestones for sales at various thresholds up to $500M

Deal 2: $25M upfront, $75M in to total milestones for sales at threshold up to $500M, $200M in milestones for sales at thresholds above $500M.

If you were to look at the headline for each of these deals, the first would tout its total deal value of $150M, whereas the second would tout its total deal value of $300M. Without any detail into the timing, likelihood or other conditions of those milestones, Deal 2 would look much better than Deal 1 when, in fact, it is likely to deliver $50M less to the seller since all parties agree peak sales are only $500M, making those higher milestones in Deal 2 unattainable.

In fact, there are actually instances where two companies will include an individual unattainable milestone just to make the deal announcement with the total biodollars more juicy for public consumption. For example, envision two companies work out a deal for a drug with standard upfronts and standard milestones. If however, the licensor wants to try to better “sell” the deal to the public, the parties can agree to include a large, individual milestone that the parties know will not ever be paid. The licensee will agree to do so because it knows it is money that will never have to be paid and the licensor gets to highlight a transaction with total value well above market expectations when in reality it is not.

Royalties Matter

For a drug that successfully makes it to market, royalties typically have the largest impact on total value transfer to the seller compared to the up-front and milestones. Royalties, however, are usually not disclosed in press releases. At best, the press release will include language such as “plus royalties on sales” or “plus double digit royalties”, but for a commercial drug, the royalty rates really do matter.

As an example, let’s assume there is a Drug Z with peak sales of $250M that is expected to be at peak for 5 years. Consider two possible deals with the same up-front and milestone consideration, but Deal 1 has a blended royalty rate of 12% and Deal 2 has a blended royalty rate of 15%. The press release for each of these transactions is likely to say “double digit royalties”. However, during the peak sales years, Deal 2 will translate into an additional $7.5M per year ($37.5M in total) in payments to the licensor than Deal 1.

Co-Promotion, Co-Developmentand Other Rights that Impact Deal Value

In addition to the upfront, milestones and royalties, there are several other levers in a deal that have a financial or strategic impact that drive long-term value. However, very rarely are any of the details of these other rights ever included in a press release.

Similar to a co-promotion right, co-development arrangements provide not just financial value but also strategic value as it allows a smaller company to build capabilities in areas it does not currently have, which can then be utilized for the other drugs in development in its portfolio.

Another key source of value is who in a deal is responsible for the future development of an asset and who pays for that development. If the licensor is still responsible for development, whether payments are classified as R&D funding or as part of a development milestone takes on increasing importance when looking at the reported deal value in a press release. There are budgetary reasons why a licensee may prefer to classify a development expense as a milestone as opposed to R&D funding, but if the licensor is expected to pay for and run a trial, the value of a development milestone that is meant as R&D reimbursement decreases (even though it is captured as part of the biodollars of the deal). R&D funding would not be captured as part of the biodollars but is equally important and valuable.

The rights the licensor retains in any Joint Steering Committee (JSC) or other diligence requirements are also important since it governs any disputes that may arise between the parties. Details of the JSC or diligence obligations are never disclosed in a press release but are an important tool for governance to ensure the value of the asset is maximized.

The value of the Partner itself

Finally, the key strategic reasons why a certain partner is best for a transaction are typically left out of the press release. Sure, there will be a quote or some other background talking about how excited the partner is to have the new drug in its portfolio, but there is little detail about why the partner brings value other than the cash consideration. However, when choosing a partner in a process, it is important to consider a number of criteria, including: development capabilities, commercial capabilities, success with similar products and its alliance management reputation. For instance, a partner with a strong, established commercial capability in the therapeutic area is likely to have lower commercial risk compared to one first building a sales force, so the likelihood of achieving commercial milestones and realize royalties is higher.

As you can see, the press release tells only a very small part of the overall value of a transaction. It is important to focus on aspects of a transaction beyond what will appear in the headlines and to have a transaction advisor that is similarly incentivized to deliver value beyond what can be listed on a deal tombstone.

At Locust Walk, we specialize in finding our clients the highest value transactions possible and provide key advice on what deal considerations should be paramount given the client’s strategic goals. If you are interested in learning more about any of the issues presented here or anything else regarding a potential transaction, we encourage you to reach out (andy@locustwalk.com) and walk with us to build your company’s lasting value.